There’s no arguing that investing is a numbers game. So it makes sense that when it comes to investing in real estate, there’s nothing more important than understanding real estate metrics.
Having a firm understanding of the key metrics in real estate investment is a crucial part of building a financially successful investment portfolio. If you don’t have a grasp on your numbers, it’s hard to determine whether or not an investment will build your wealth — or drain money from your portfolio.
For example, let’s say you were investing in a multi-unit rental property and were trying to determine if it would be a profitable investment. Before making that determination, you’d need to know your operating expense ratio and your gross rent multiplier; without it, you could easily underestimate your operating costs and/or overestimate potential rental income — and quickly find yourself in the red.
But what kind of data do you need to include on your real estate metrics dashboard? What numbers do you need to know?
Let’s take a look at the most important real estate metrics — and why you need to know them:
Down Payment Requirements
The down payment requirements for owner-occupied properties and investment properties can vary widely, so before you spend a lot of time looking into a property, it’s important to understand how much you’ll have to put down in order to add it to your portfolio — and if that number makes sense with your budget.
While independent buyers who plan to live in a property can secure a mortgage for as little as 3.5% down (with an FHA loan), investor down payments are much higher and can run you anywhere from 20% all the way up to 40% or more, depending on your lender.
So, if you were looking at buying a $500,000 property, you would need to have $100,000 to $200,000 in liquid assets — mainly cash — to make the purchase.
This number is important to know because if you don’t have the liquidity necessary to meet your lender’s down payment, you don’t want to waste time on the property.
Operating Costs/Operating Expense Ratio
When you invest in a property, it’s imperative to know how much it will cost to own that property every month. Your operating costs are — you guessed it — the costs associated with operating your investment property. Operating costs include everything from maintenance to property management to your mortgage payment.
The operating expense ratio is your total operating costs divided by your income; this ratio will show you what percentage of your total income is being put towards operating costs.
So, for example, let’s say your rental property costs $5,000 per month to operate, and it brings in $6,000 per month in rental income. Your operating expense ratio would be .83 ($5,000/$6,000), which means that 83% of your total income goes towards operating costs.
This number is important to know because if your operating expense ratio is over 1, it means you’re spending more money to operate your property than you’re bringing in, and you need to find ways to cut costs if you want to get profitable.
Capitalization Rate
The capitalization rate (also known as “the cap rate”) is another formula that helps to determine the profitability of a property. The cap rate is determined by taking the total income (also known as the net operating income) and dividing it by the current value of the property. In a nutshell, the cap rate tells you how much return you’d get on your investment if you owned the property outright.
For example, let’s say your property is valued at $500,000 and has a net operating income of $50,000. The property would have a cap rate of 10% ($500,000/$50,000).
The cap rate can help you determine whether a property is a sound investment, especially as the market fluctuates.
Cash Flow
One of the most important metrics for any given property is its cash flow. Understanding a property’s cash flow is crucial in evaluating the investment and determining its profitability.
There’s a few different parts to determining cash flow, including gross income (how much money you anticipate making with the property), vacancy and credit losses (an estimate of how much money you might lose on your gross income due to vacancies and outstanding debts), operating costs, net operating income, principal and interest payments, and taxes.
For a property to be profitable, you need to be able to cover all expenses using the income the property brings in; otherwise, you’ll find yourself with a negative cash flow, meaning you don’t have enough cash to cover your expenses — which might lead to defaulting on your loan.
Cash-on-Cash Return
The cash-on-cash return measures your cash return for a given year against the cash you invested when you purchased the property. In other words, it’s the annual pre-tax cash flow divided by the total cash invested in the property. This gives you a clear picture of an investment’s annual performance, which will help you determine whether the property is worth keeping in your portfolio.
So, for example, let’s say you invested $100,000 cash in a property and it brings in a cash flow of $40,000 this year. Your cash-on-cash return would be 40% ($40,000/$100,000).
Keeping Your Real Estate Numbers Organized
It’s important to keep all of your real estate investment data meticulously organized; that way, you can easily review the performance of your investments, properly manage your cash, analyze your growth, and make educated decisions regarding your properties.
You can keep track of your numbers in a spreadsheet or use accounting software, like QuickBooks. If you have a large portfolio of investments, you might want to consider hiring a bookkeeper who can manage your metrics.
How Your Property Manager Can Help
Managing your real estate investment metrics is a big job, but thankfully, you’re not alone. Your property manager can be a huge help in keeping you informed about your metrics — and save you money in the process.
Since your property manager manages the day-to-day operations of your property, they can keep you informed on changing operating costs, vacancies, and outstanding debts that might affect your cash flow, and any changes in the market that might affect rental prices. By working hand in hand with your property manager, you’ll have the most up-to-date metrics that will help you determine the performance of your property — and make sure you continue to profit.
Understanding your numbers is crucial to real estate investment success. And LEAP Property Management is here to help. Get in touch today to learn more about our property management services.
